Dollar Premium Seen Widening From Six-Month High: China Credit

By David Yong and Andrea Wong -
Apr 1, 2013

Investors are seeking the highest
yield premium in six months to own Chinese dollar-denominated
debt and Societe Generale SA predicts further widening as the
U.S. economy builds up steam while China’s retools.

The spread over Treasuries surged 71 basis points, or 0.71
percentage point, to 367 basis points in the first quarter, the
widest spread since Sept. 27, according to an index compiled by
JPMorgan Chase & Co. That ended a five-quarter narrowing run
that was the longest on record. The similar gap for Indian debt
narrowed 24 basis points, while that for Russian widened by 11
and Brazil’s by 34.

A flood of cash into emerging markets seeking higher
returns is slowing as economists forecast U.S. 10-year Treasury
yields will rise over the next 12 months and most Federal
Reserve officials see bond purchases ending this year. Bond risk
in China is rising after Premier Li Keqiang said on March 17
that the government will withdraw the hand of the state and
solar panel maker Suntech Power Holdings Co. defaulted on a $541
million convertible note on March 15.

“Higher U.S. yields will reduce the need for insurers to
keep buying more credits,” Guy Stear, head of credit research
in Hong Kong at Societe Generale SA, said in a phone interview
on March 27. “Developers and raw-material companies have low
levels of liquidity and I’m afraid we are going to see more bond
issuances. That puts us somewhat in a gloomy mood for the coming
quarters.”

The day after Stear spoke to Bloomberg News, the JPMorgan
Corporate EMBI China Blended Spread index jumped 33 basis
points, the most since 2011, and the Shanghai Composite Index of
shares sank 2.8 percent on concern tighter lending rules will
hurt bank earnings and economic growth. He recommended buying
credit-default swap protection on Hong Kong developers, saying
weaker home sales could force companies to sell more debt to
boost their cash balances.

The cost to insure China’s debt against non-payment for
five years climbed seven basis points in the first quarter to 74
basis points in New York, according to data provider CMA, which
is owned by McGraw-Hill Cos. and compiles prices quoted by
dealers in the privately negotiated market. Contracts on bonds
of Agile Property Holdings Ltd. (3383) cost 659 basis points, down from
674 on Dec. 31, CMA data show. Those for Sun Hung Kai Properties
Ltd., Hong Kong’s biggest developer, were unchanged at 135.

Staying Home

Flows into bond funds continued to pivot toward the U.S.
and away from European and emerging markets in the week to March
20, according to data published by Cambridge, Massachusetts-
based EPFR Global. U.S. funds took 80 percent of the $3.7
billion bond inflows, while commitments to emerging-market debt
were the second-lowest in 2013.

Chinese and Hong Kong companies sold a record $21.3 billion
of new bonds this year, accounting for 52 percent of issuance by
Asian companies, according to data compiled by Bloomberg.
Zhongshan, Guangdong-based Agile led $12.5 billion of fund-
raising by developers. Its $700 million 8.25 percent perpetual
bonds lost 2.1 percent since they were sold on Jan. 18.

Sunac China Holdings Ltd. is marketing $500 million of 2018
dollar bonds at 9.375 percent, after 8.375 percent perpetual
debt by fellow developer Beijing Capital Land Ltd. rose on its
debut last week.

Pulling Back

Union Investment Privatfonds is trimming its Chinese debt
holdings, which were slightly higher than the benchmark against
which it gauges performance.

“This market has grown very rapidly in the recent two
years from almost zero and the supply pipeline is still very
huge, putting pressure on valuations,” said Sergey Dergachev,
who helps manage $8.5 billion of emerging-market debt in
Frankfurt at Union Investment. “A lot of the underperformance
came from the adverse move in Treasuries.”

Union is avoiding China Metallurgical Group and Sinochem
International Corp. (600500) because their debt-load puts ratings at risk
of becoming junk, and CNOOC Ltd. because it may sell more bonds
to fund its acquisition of Canadian oil producer Nexen Inc.,
Dergachev said in an e-mail on March 27.

Sinochem International’s long-term debt has risen to 92
percent of its equity, from 59 percent a year ago. Franshion
Properties China Ltd.’s debt is 67 percent of its equity.

Economic Slowdown

Government reports last month showed manufacturing and
export indicators in February trailed economists’ estimates,
stoking concern an economic rebound is losing traction.

Chinese policy makers set a 7.5 percent growth target for
2013 after the world’s second-largest economy grew 7.8 percent
in 2012, the slowest rate since 1999. They are targeting 3.5
percent inflation, down from a goal of 4 percent the previous
year, emphasising control on housing costs. Home prices rose 1.1
percent in March from February, the most in two years, according
to data released today by SouFun Holdings Ltd., the country’s
biggest real estate website owner.

About 17 cities have issued details of property curbs by
the end of the first quarter. The capital city of Beijing banned
single-person households from buying more than one residence,
while Shanghai prohibited banks from giving credit to third-home
buyers, the local governments said over the weekend. Lenders in
Hong Kong raised mortgage rates after the city’s government
doubled stamp duty on property purchases exceeding HK$2 million
($258,000) to damp prices that have tripled since 2004.

Hedge-Fund Bull

The tightening measures will make the market healthier,
making property bonds a buy, according to for Rahul Sharma, an
emerging-market bond investor at Finisterre Capital LLP, a
London-based hedge fund manager with $1.6 billion of assets.

“I’m bullish on the Chinese property market; it’s a
capitalist system within a communist country,” Sharma said in a
March 27 e-mail interview. “Valuations are still attractive,”
supported by strong state ownership in some companies and higher
relative yields, he said.

The securities underperformed last quarter due to supply
pressure and Finisterre is betting on a rebound as “unrelenting
noises” on Europe’s debt crisis diminish, he said. Sharma co-
manages a $400 million credit fund which gained 16.4 percent in
the past 12 months through February. Its holdings include
Franshion, Shimao Property Holdings Ltd. and China SCE Property
Holdings Ltd.

Suntech Effect

Yield spreads widened inside China in March. The yield on
three-year AA notes rose seven basis points, the most since
September, to 5.15 percent, widening the gap over similar-
maturity AAA debt to 70 basis points, Chinabond data show.
China’s 10-year bond yield fell four basis points in the last
quarter to 3.54 percent, Chinabond data show. The yuan rose 0.2
percent in the last three months to 6.2108 per dollar in
Shanghai and reached a 19-year high of 6.2077 today.

Investors are wary of the potential for more defaults in
China, as well as Europe’s debt crisis, according to Connie Chou, a bond fund manager at Eastspring Securities Investment
Trust Co.

“The concern over transparency and corporate governance
has resurfaced after the Suntech incident,” Taipei-based Chou
said in a March 27 interview. Her firm manages NT$128 billion
($4.3 billion). “It makes a lot of sense for investors to
demand higher yields on Chinese dollar bonds.”